![]() There have been some dislocations already. These are but two examples of potential fallout from unspoken assumptions as economic reality changes. When it becomes apparent this is no longer true, it may cause a step change in CRE valuations. Thus, if you issued debt, it was a virtual certainty you'd be able to reissue it again down the road at a lower interest rate, or sell the property at a lower cap rate than you paid. Prior to 2022, there had been fewer than five months since 1980 when the 10-year Treasury was not lower a decade later. But there's also risk due to the pernicious assumptions ingrained in investor psychology after forty years of declining rates: that refinancing is always possible, that new debt will be issued at a lower rate than old debt, and that cap rates are perpetually declining. There are obvious economic headwinds due to work-from-home. The string has a lot of slack that needs to be reeled in before we see real economic effects.Īnother area of concern is commercial real estate. After many years of pushing on a string, distorting financial markets to try to bring strength to the real economy, the Fed is now attempting the reverse. We have argued that, due to the new inflationary environment, there is now a "Fed call," a limit to how much investors can make rather than how much they can lose, as the Fed will need to stomp on the brakes whenever the market and economy get too hot. This is perhaps best illustrated by the notion of the "Fed put," the assumption that the Federal Reserve will step in to rescue the equity market should it decline. A trend that persists for so long inevitably becomes ingrained into investor psychology. For the past forty years - most investors' entire careers, and our entire lives - interest rates have been declining. Virtually overnight, these distortionary impulses were withdrawn.įundamental assumptions will be challenged. And in just the last few years, we've seen the greatest monetary policy experiment of all time, with negative real interest rates and trillions of dollars of quantitative easing, and the greatest fiscal policy experiment of all time, with record transfer payments supporting the economy. We have just seen the end of various multi-decade trends in interest rates and inflation. However, this feels like wishful thinking. ![]() The Goldilocks "just right" economy - where inflation falls rapidly back to the Fed's 2% target without significant pain for corporations, consumers or credit - is possible as well. Our personal view is that the too-hot scenario is the most likely - the labor market and hence the consumer remains extremely strong - but either outcome seems possible. A cold economy with recession is a problem for earnings. A hot economy with stubbornly elevated inflation is a problem for valuations. Thus, the equity risk premium remains perilously thin.Įquities are priced for a Goldilocks economic scenario: not too hot, not too cold. Since we published Part III: Apex of a Bubble on September 21st 2021, we’ve seen the largest reduction in fiscal stimulus on record, the fastest spike in real yields, the worst annual performance for Treasuries, the fastest pace of monetary tightening in generations, and the reversal of a decade of quantitative easing and zero interest rates.ĭespite the S&P's bubble-like valuations in 2021 and the subsequent upheaval in many corners of the financial markets, the S&P is up 3.5% since Apex of a Bubble. Yet equity indices remain eerily resilient. Speculative securities have been decimated, the fed funds rate is now 5% higher, the real yield on TIPS has gone from nearly -1% to over 1.5%, and analyst estimates for 2023 S&P 500 earnings have come down -6%. That script played out largely as we expected. We wrote: "Extreme valuations presage real returns that investors will find severely disappointing - and likely negative - for many asset classes over years to come." ![]() We predicted severe declines for the most speculative growth names, strong relative performance for value stocks, and the rise of interest rates due to the return of inflation. You can also follow us on Twitter here and here.Ī year and a half ago, we had just finished our “Everything Bubble” series, and the path ahead seemed remarkably clear to us. You can adjust your subscription preferences here. We have separate email lists for investment theses, CIO Corner thought pieces, and monthly performance updates. Between formal investor letters, we will continue to release plenty of content. ![]()
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